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The hedger uses the tools of the market place to manage risk.
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This is different from
the speculator, who trades the market to make a profit. The hedger is
managing the risk of his/her business by transferring price risk to
the market place. Because cash prices and futures price move in tandem
with each other, the business owner (farmer/rancher) can hedge their
commodity even when there is not an active cash market.
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The hedger must be aware of the basis.
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 The basis is the cash price minus the nearby futures contract. In some areas of the country, the
basis is negative and in other areas it is positive. The basis also varies from commodity to
commodity. To make good marketing decisions, an understanding of your local basis is required.
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A marketing plan that is locking in prices will probably have several entrance points.
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For example, if you are selling, your first sale will be at a loss when you sell your second sale
objective. This pattern repeats itself at each higher price. The same is true if you are purchasing
products. As the price drops to your second buying objective, you have a loss on your first purchase.
The paper losses in both examples are offset by gains in the cash market. Hence, the reality
of a true hedge.
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The hedger is a long-term
trader, while the speculator is a short-term trader.
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The hedger typically leaves a position in place until a cash price is established. Then the offsetting
futures position is lifted. In the case of a seller, the hedge is bought back. In the case of a buyer, the
hedge is sold back.
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The result of hedging is transferring price risk to the market.
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Hedging does not give the top or the bottom in the market. In fact with hedging you will probably
miss both the top and the bottom. Hedging does give peace of mind in having the knowledge of
what your product is worth on the buy or sell side.
Commodity trading is not suitable for everyone.
While there is potential for profit, there is an equal chance for loss. Past performance is not related
to future performance. You need to understand your personality before trading.
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